Corporate & Commercial 03 October 2024

Is Your Business Positioned for an Optimal Sale? The Importance of 12-18 Month Planning

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Selling a business is a key milestone to an owner and founder. It can be a challenging process faced with new concepts, risk management and the psychological impact of exiting a business that was once an owner’s pride and joy.

If an owner fails to prepare its business for sale, then it may be faced with a delayed exit (to sort through various issues during the transaction), a reduced purchase price (to account for risk), imposition of an earn-out (to shift the risk from the buyer to the seller), and increased risk of claims after completion of the sale.

An owner can minimise the challenges of a sale event with enough preparation and planning, usually 12 – 18 months before exit, with assistance from experienced advisors.  It’s recommended to engage financial and legal advisors as early as possible to work through and solve potential issues – before a buyer starts questioning the health of the business. Ultimately, the more an owner prepares, the greater likelihood of minimising claims, de-risking the transaction and receiving greater payment for the business.

Structuring of the transaction

One of the most important steps is to implement the correct structure of a transaction. This can be worked through with a quality corporate / deal advisor and tax accountant together with lawyers. Key items that should be considered is whether the owner intends to stay on in the business and the preferred buyer (e.g. family succession plan, management buy-out or the most appropriate private equity fund -noting each fund may offer different advantages). I have a range of suitable structuring advisors in our network that can assist.

For the purposes of this article, I have adopted the sale of business – the transfer of all assets from one entity to another.

Negotiating terms sheets

A brief note that sellers and buyers should always consult with their team of advisors at the terms sheet stage. While terms sheet set out key terms of a deal and are often classed as “non-binding”, the terms sheet usually provides a basic framework and guide for the larger suite of legal documentation. It is best that any issues are dealt with prior to signing given market practice is to treat this as a “handshake agreement”.

Seller due diligence

As part of preparing your business for sale, I recommend a seller conduct due diligence on its business prior to actively selling your business or engaging a buyer. This process will enable a seller to identify and correct any key risk areas and therefore gain greater confidence in the health of the business.

This article will only consider legal due diligence, but it is recommended to review commercial and financial due diligence.

Corporate registers

All constituent documents should be identified and reviewed to ensure that these are correct and accurately reflected on public registers.

Key Contracts

A key component will be to identify and review all material contracts – whether procurement contracts, sale contracts, terms of trade, licensing or joint ventures – that are critical to a business’s success and profitability. These contracts should be identified to ensure they are on commercially standard terms having regard to the nature of the contract, any onerous terms (such as minimum orders, payment of an exit fees, termination rights) are identified and potentially negotiated out, and change in control consents are identified.

For example, a business should seek to ‘lock in’ a key customer contract rather than relying on a purchase order or, worse, a handshake agreement – the customer should be ‘locked in’ with minimal exit arrangements. Meanwhile a software manufacturer should be seeking ownership and assignment of all intellectual property rights from any suppliers, software developers etc.

Constituent documents

The constituent documents of the target should be reviewed. For example, a shareholder’s agreement may amend terms of the Constitution and contain key governance requirements to affect the proposed transaction. An example of this would be matters requiring board or shareholder approval, the imposition of pre-emptive rights on shares (first right to buy) or other restrictions on the transfer of shares.

Insurance Requirements

A review of the business’s insurance policies is necessary so that there is adequate insurance coverage for the business. This would also help a seller identify common areas that are claim for insurance and consideration can be given to implementing new procedures or policies to mitigate these claims in the future. It is also good practice to obtain the certificates of currency so that these can be provided to the buyer.

Employees

It is critical that the details of all employees are identified and reviewed. The employment terms and relevant awards should be identified and review compliance with health and safety laws, workplace injury and any claims or incidents reviewed and/or mitigated in the future.

A buyer will expect to receive a detailed list of employees, including their names, positions, employment status (full-time, part-time, or casual), wages, and employment agreements, and awards.

Intellectual Property

All intellectual property, whether owned or licensed, should be identified and reviewed. This review would encompass whether the business has necessary ownership rights that it needs (for example, this is critical for a software manufacturer to own the intellectual property behind the software) but also whether the use of intellectual property infringes any third-party rights. Searches of public intellectual property registers should also be undertaken.

Superannuation

Buyers should ensure that all superannuation payments have been properly made for employees. This is particularly relevant with recent changes to superannuation and also checking that there is no error in policies and procedures.

Property Leases

All leased and owned properties will need to be identified. All leases and licences will also need to be reviewed for key terms – the standards are expiry of lease, options for further terms, make good provisions and change of control consents required. Often a seller will also own the freehold land under which the business operates from – if this occurs then it is imperative that an arms length / commercially standard lease is entered into between the landlord and company.

Litigation and Disputes

A seller will likely need to disclose any ongoing or past litigation. Accordingly, a seller should take a keen interest in ongoing claims (which are easily identifiable by court searches) to determine the basis of the claims, the ability to settle these promptly and implementing procedures to reduce the risk of similar claims occurring in the future.

Debt management

There should be a review of the credit terms offered to customers and ensuring there is a strong process for collecting debts in a timely manner. Also, supplier terms should be reviewed to see if payment terms are adequate to enable cash flow to the business.

Personal Guarantees

Sellers should identify any personal guarantees that have been provided and seek the release of these on completion of the proposed transaction.  This will provide the seller with certainty knowing it has properly exited the business.

Public Registers and Security Interests

A buyer will conduct public searches on registers such as ASIC, IP Australia, and the Personal Properties Security Register (PPSR). The seller should ensure that information contained on public registers is accurate and matches the information contained withing the company’s corporate records.

Also, the seller should review any security interests granted to determine if any are dormant / legacy that can now be removed, items that relate to excluded assets (e.g. personal motor vehicle), and know which interests must remain with the company at completion (for example, a security interest securing financing facilities will need to remain unless the buyer is bringing alternative financing).

Environment, Social, and Governance (ESG) Compliance

ESG compliance is becoming increasingly important. A seller should assess its compliance with environmental regulations, social responsibility standards, and governance practices to avoid potential penalties or reputational damage.

Related Party Transactions

Any related party transactions involving the business should be reviewed and put on arms length / commercially standard terms. For example, a lease of the property occupied by the business and owned by the sellers should be updated so it is a market standard lease.

Summary

To effectively prepare for a business exit, it’s essential to start the process 12-18 months before engaging a buyer. This timeframe allows sellers to strategically plan the transaction and ensure the company is operating at its best. The ultimate goal is to maximise the sale price while minimising the risk of future claims.

Although these preparatory steps can be time-consuming, they should be viewed as integral to good corporate governance and best practices. Having appropriately qualified and experienced advisors, including lawyers and accountants, involved early in the process is an important consideration. By proactively addressing potential issues, sellers can facilitate a smoother and more successful exit.

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